The crisis in the eurozone is critically important for Asia. At a distinguished speaker seminar at ADBI on 1 December 2011, three eminent European economists examined the crisis and put forward tentative solutions. In this post based on the seminar transcripts, Stefan Collignon outlines his hopes and fears for the single currency.
We are in the midst of a very severe crisis. It is not clear that the euro will survive, and if the euro does not survive then the European Union will not survive, and if the EU does not survive than I am not sure how much longer we will have peace in Europe.
How do we explain the causes of the crisis? There are two approaches.
The fundamentalist approach says it was the lack of fiscal discipline and excessive deficits and debt that caused macroeconomic imbalances, and that the answer to the crisis is austerity.
The monetarist approach says that the crisis was caused by a liquidity shock that started with the 2008 global financial crisis and was reinforced by the Greek confidence shock, which was politically determined by the elections in 2009 when then Greek Prime Minister Georgios Papandreou found that his predecessor had been lying to Brussels on public deficits.
So far, remedies to the crisis have been setting up the €780 billion bailout fund and the unorthodox European Central Bank measures of the Covered Bond Purchase Program and the Securities Markets Program. These steps have been resisted by the German Chancellor Angela Merkel and therefore followed by the logic “too little, too late”.
As an answer to the liquidity crisis, the European Commission has proposed setting up Eurobonds, which has incensed Merkel. The European Commission’s Eurobond bid has three options:
- full substitution of all outstanding government bonds with joint and several guarantees,
- partial substitution with joint and several guarantees, or
- partial substitution with several, but no joint guarantees.
The first two options are unlikely to be realized because member states would have to assume the debt of others, which would require a change to the Maastricht Treaty. Germany has blocked everything, but some people hope that Merkel will turn around on the Eurobond idea. The third option is acceptable under the treaty. Could it help? The answer is, maybe. Whichever option is followed, Europe must act quickly on the Eurobond plan.
Furthermore, Europe must move forward and deepen its political integration—including introducing Eurobonds and more stringent policy coordination mechanisms – or otherwise it will disappear as a global player and sink into irrelevance. Whether it does that or not is a matter of political will.
Will the euro survive? I am biased. I want it to succeed and I want Europe to stay together, However, I am extremely worried and I believe that the main obstacle is political. We need the political will to acknowledge at the political level what we have done on the economic level. The problem is this contradiction between what is effectively fully integrated by money so that a European single market can function and the idea that sovereign states can still do whatever they want. I don’t think that works, but neither Sarkozy nor Merkel and the rest are willing to acknowledge that. The consequence is that we have many half-hearted proposals that try to deal with this issue without moving to a propos political Union. The guiding principle should be “no taxation without representation.”
Big spending will stay in Europe for many decades with national governments and this is very different from US fiscal federalism. In Europe that will not work because fiscal policy needs to be centralized for stabilization purposes, while the allocation function could well remain decentralized. There are ways to tackle these two functions of public finance. For example, my preferred solution is an aggregate budget law that establishes what should be the aggregate deficit for the eurozone in response to the business cycle. Deficit permits could then be allocated to member states according to GDP shares, which could be traded like pollution permits. And if banks would not be allowed to lend money to public authorities unless they get these deficit permits, then one would control deficits at source just as we tax people at source.
Is Greece or Italy insolvent? I don’t think so. How we define insolvency is the issue. With excessively high interest rates and negative growth, debt is, of course, growing rapidly, but if these conditions could be revised, debt would quickly fall again. Their problem is liquidity because of political interference and mishandling – interest rates are rising to levels that could become unsustainable.
But that pushes the issue in a different direction. Then the issue is about how do we deal with the liquidity issue rather than how do we reduce the deficits. In a liquidity crisis what matters is the stock of debt. Merkel, who understands close to zero about economics, only emphasizes the increases – budget deficits. She does not see how what she is doing is affecting the willingness to hold debt stocks. Her biggest mistake was private sector involvement (PSI).
Economists are the prime disciples of George Orwell, and their ways of twisting language is extraordinary. “Moral hazard” is effectively cheating, lying, stealing, but we don’t call it that way. Now we talk about “debt restructuring,” “forgiveness” for what is effectively expropriation of wealth. What I find fascinating is that capitalists want to expropriate bond holders – this used to be Lenin’s domain. This is what PSI means. Do you think you can fix things in the communist way by taking away property from people? And then expect Greece to go back to the market? The Greeks will then say: Great! Now we are going to borrow more. This isn’t the answer.
The big issue in Europe is how to tackle growth. Unemployment looks bleak. But in the first 10 years of the euro 15 million jobs were created, the biggest job creation in Europe’s history. Of these 15 million we have lost 5 million jobs in the crisis, so we are still 10 million ahead. What the euro has achieved is not bad and that’s why I want to preserve it.
The ECB and EU politicians have only got themselves to blame: a bit of due diligence back in the 1990s about the state of Greek public finance would have prevented today’s crisis.